A collection of thoughts, musings and opinions at the intersection of economics, politics and culture...

Friday, September 4, 2009

Economic Navel Gazing...

PAUL KRUGMAN has a new piece up on the NYTimes website on new debates within the Economic community springing from the economic meltdown.

Krugman can be tough to take -- in fact some members of the Commission find his smug certainty that he is always right, and significantly smarter than everyone else in the room almost intolerable -- but this piece is definitely worth reading.

There are a number of telling points in the article dealing with the fact that most economists never even saw the possibility of the current recession...

stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year.

As a result of this failure, Krugman sees Economics returning to Keynesian thinking - which of course coincides nicely with his increasing support for Government intervention in the economy...

Krugman uses as an example a true story of a babysitting co-op in Washington DC:

This co-op, whose problems were recounted in a 1977 article in The Journal of Money, Credit and Banking, was an association of about 150 young couples who agreed to help one another by baby-sitting for one another’s children when parents wanted a night out. To ensure that every couple did its fair share of baby-sitting, the co-op introduced a form of scrip: coupons made out of heavy pieces of paper, each entitling the bearer to one half-hour of sitting time. Initially, members received 20 coupons on joining and were required to return the same amount on departing the group.

Unfortunately, it turned out that the co-op’s members, on average, wanted to hold a reserve of more than 20 coupons, perhaps, in case they should want to go out several times in a row. As a result, relatively few people wanted to spend their scrip and go out, while many wanted to baby-sit so they could add to their hoard. But since baby-sitting opportunities arise only when someone goes out for the night, this meant that baby-sitting jobs were hard to find, which made members of the co-op even more reluctant to go out, making baby-sitting jobs even scarcer. . . .

In short, the co-op fell into a recession.

What Krugman ignores by using this story is that the co-op members self selected to join the group, and therefore had common characteristics that made it a structurally inefficient economy. Babysitting is not generally an occupation that parents would choose to do, and the fixed exchange rate of the currency does not create enough value to overcome the inherent challenges in getting parents to do additional babysitting in trade for future babysitting.

While the Commission is happy to see Economist begin to appreciate that not all markets are perfect, and not all individuals make "rational" decisions, it is is not excited by calls to return to pure Kaynesian thought. In the Commissions view, Keynesian thought discounts the Externalities caused by government intervention in the economy, and those externalities played a big (but almost universally ignored) part in the lead up to the economic collapse.

While the Commission does not agree with neo-classical economists that unemployment is driven by people making a conscious choice to work less.... it does recognize that government policy has created some of the joblessness...

By relentlessly advocating increased home ownership and failing to encourage citizens to understand the trade-offs that come with owning a home, it played a large part in causing the bubble... Government policy ignores the fact that owning a home makes it much harder to move to find a new job. In fact, through action at the local, state and federal level, government encourages people to think that they have a pre-ordained right to have a job in the community of their choice. Through advocacy, government has created an entire cadre of irrational consumers, as well as fundamentally irrational markets in employment and housing...

Mr. Krugman would ignore that fact, and advocate for increased government action.